To rein in social media, the market will suffice

The suit filed against Facebook by the Federal Trade Commission and 45 states’ demanding its breakup seems to ignore the competitiveness of the U.S. digital market while raising ghosts of past failed suits.

The strength of the U.S. economy is not its size or its colossal firms but its competitiveness, dynamism and relentless innovation. These attributes have enabled numerous startups in the U.S. to introduce radically better products and services at ever lower prices. It’s not merely long-standing businesses with deep pockets that introduce innovations. The powerful truth is that new entrants, often started by immigrants to the country, innovate, outwit and obsolete their predecessors. Consider some of these dramatic changes.

Around the 1970s, IBM dominated the mainframe computer market, so much so that the Justice Department filed an antitrust suit against it, which dragged on for thirteen years. In the interim, the personal computer revolution upended the mainframe computer market. Two new startups, Intel and Microsoft, ended the dominance of IBM. This market-driven change was much less costly and more efficient than the antitrust suit that the government filed against IBM at enormous cost and no fruition.

Similarly, in the 1970s, Xerox had a stranglehold on copying markets, triggering an FTC antitrust suit. The company resolved the suit with a consent decree licensing its patents to competitors, which Japanese firms exploited. However, personal computer and printer revolutions rendered the need for copiers obsolete, ending Xerox’s dominance. Again, change wrought by the market was swift, efficient and deadly. Xerox never recovered from its pass on the personal computer revolution.

In the 1990s, Intel and Microsoft prevailed in the personal computer market, with about 85 percent of shares for chips and 95 percent for operating systems, respectively. Throughout the 1990s, the FTC conducted several antitrust investigations of Intel. Two of these ended with no judgments against the company, while one ended with a settlement. Likewise, in the 1990s, first the FTC and then the Justice Department filed charges against Microsoft’s monopoly of the personal computer market. A judge ordered the breakup of Microsoft. But that order was overturned on appeal. In both cases, while oversight had merit, lengthy, costly litigation against the apparent monopoly of these two companies was perhaps unnecessary.

An explosion in sales of mobile phones limited the usefulness of personal computers and reduced the dominance of these two companies. Intel, overly focused on personal computers, dropped the ball on the mobile chip market. Microsoft’s share of operating systems for mobile phones was never above 4 percent. Its costly purchase of Nokia turned out to be a failure. The new entrants that successively grabbed leadership of the hyper competitive mobile phone market were first Motorola, then Nokia, then BlackBerry, then Apple, followed by Samsung and now perhaps Huawei. This sequential fall of these giants reveals the competitiveness of the mobile phone market. In each of these cases, innovation brought about change more efficiently and swiftly than the Justice Department or FTC could have done.

The browser market is another vivid example of intense competition in tech markets. Safari and Firefox are threatening Google Chrome, which surpassed Microsoft’s Explorer, which disrupted Netscape, which took the place of Mosaic. In each transition, ease of use, superior features and better quality prevailed. The market provided its own discipline, moving too fast for bureaucrats to file and win antitrust cases. 

Online search likewise is plagued with rivalry and competition. Google quickly displaced Yahoo’s Alta Vista. While Google seems dominant, it’s so only because of its relentless innovation in streamlining its engine. Even then, the dominance of Google search has been greatly limited by Facebook’s and Amazon’s search engines, which provide their own respective customers an in-house option to browse news, entertainment or products for sale.

What about the social media market and Facebook’s dominance? Some economists and lawyers have postulated that the power of network effects renders incumbents invulnerable here. However, my research has shown just the opposite: network effects — the phenomenon where a product or service gains additional value as more people use it — stimulate entry and support the victory of superior quality. Facebook was not the pioneer of social media. It was preceded by Myspace. If network effects were all that they are cracked up to be, Myspace would still be thriving. But Facebook quickly obsoleted Myspace. Facebook has faced constant competition from upstarts, including Twitter, Instagram, Snapchat, WhatsApp, LinkedIn, Pinterest and now TikTok. Even in the market where network effects are supposed to prevail, consumers are quick to embrace new services that provide better benefits. 

So, what is the best strategy for governments to rein in dominant companies? 

First, keep markets open to new entry, both domestic and international. That means encouraging rather than suppressing entrants like TikTok.

Second, like California, do not enforce non-compete clauses. Titans of industry use such clauses to prevent talent from leaving to start businesses of their own. However, this outflow of talent is essential for startups that keep markets innovative. 

Third, do not easily approve horizontal acquisitions of direct competitors, such as Facebook’s acquisition of Instagram. 

Fourth, encourage foreign talent to migrate to the U.S., for education, enterprise or other motives. 

Fifth, adopt tax policies that encourage research and startups within the country rather than elsewhere. 

And sixth, use lawsuits judiciously, especially in fast moving, competitive markets. Lawsuits are hugely costly to defendants and taxpayers. Time, effort and resources that defendants spend on defense are diverted from fresh innovation that brings new benefits to consumers and fosters dynamic markets. 

Dr. Gerard J. Tellis is the Neely Chaired professor of American Enterprise, director of the Center for Global Innovation, and director of the Institute for Outlier Research in Business, at the Marshall School of Business, University of Southern California. Among his numerous publications on innovation are “How Transformative Innovation Shaped the Rise of Nations: From Ancient Rome to Modern America and Unrelenting Innovation: Creating a Culture for Market Dominance.”